Background and Challenge
As agribusiness operators face increasing competition in South America, companies have been looking to extract products and by-products more effectively by leveraging the same raw materials with better technology. While Brazil leads South America in sugar refinery, and has a well-developed bioethanol sector, companies there have taken steps to diversify into other complementary agribusiness segments, including higher value oleochemicals.
A leading Brazilian integrated agribusiness and food company with sugar mills around the world was looking to introduce innovations in the oleochemical space and utilize all parts of its sugar refinery chain more effectively. To do so, the company partnered with a leading technology firm focused on converting low-value sugars into higher value fatty acids. Such acids can be sold into the personal care sectors (detergent and soap) to help diversify revenue. While the two firms reached a tentative joint venture agreement, they enlisted L.E.K. Consulting to evaluate the economics of the venture for both sides.
The key challenge was to understand the value of the two companies’ contributions to the joint venture and the implications of these valuations on the joint venture equity and cash determinations – all under a variety of potential market scenarios/outcomes.
Approach and Recommendations
L.E.K. evaluated a highly complex value chain to map each company’s contributions to the ultimate product’s value today and moving forward. Teams from L.E.K.’s Boston, San Francisco and Los Angeles’ offices began by creating a traditional static discounted cash flow (DCF) valuation of the joint venture. However, this conventional approach resulted in a negative net present value (NPV), due to the underlying volatility of commodity prices.
Consequently, L.E.K. utilized a simulation-based approach to model the volatility of sugar and palm kernel oil prices as well as exchange rates to better understand the risk profile of the joint venture. With these simulations, including assessments of customer uptake expectations and pricing of the end products, L.E.K. realized the current deal structure was inoperable as the two companies did not equitably share in risk.
L.E.K. determined that a deal restructuring was required and utilized our analyses to provide the client with:
• A pressure test of the joint venture’s current business plan and baseline assumptions with a DCF valuation
• An objective third-party valuation of both parties’ contributions to the joint venture
• A robust, user-friendly cash flow and valuation model
The companies were able to effectively and equitably renegotiate the deal based on L.E.K.’s analyses. In 2014, the joint venture produced its first saleable product and is expected to reach full operating capacity within 12 months.